Engaged Investor

Among the many lessons learned by trustees as a result of the financial crisis, none have been more important than the need to regularly review funding, looking at the relationship between assets and liabilities, and holding to account under-performing managers.

Many schemes – such as Barclay’s UK Pension Fund – have responded to these pressures by taking investment management expertise back in-house and in some cases, appointing their own chief investment officers to help bridge the gap.

Others, such as Habitat (below), are looking at moving in the opposite direction and considering options such as fiduciary management. Fiduciary management aims to cut away the complexity of trustees needing to monitor several asset managers by contracting out investment management to just one provider, which takes on the responsibility of constructing portfolios to manage the investment strategy agreed by the trustees, and of appointing asset managers to run the different aspects of the portfolio.

A fiduciary manager is able to take a total overview on the assets and liabilities of the pension scheme, while being able to concentrate solely on monitoring investment performance and acting on the results of that monitoring. Through that the fiduciary manager can help to guide the scheme to whichever end point trustees have chosen, such as full funding or a buyout. This should free up trustees to concentrate on more important concerns, such as setting the overall strategy of the scheme.

Take off

The concept of fiduciary management came to the UK a few years ago from the Netherlands, where it has proven highly popular. Indeed, fiduciary management is already so entrenched in the Netherlands that only one quarter of Dutch schemes do not use it.

Take-up in the UK has been far slower. Reasons cited include the difficulty in building momentum – the argument being that until a few big deals are done, other schemes will be loathe to commit to the approach – and the substantial change in trustee attitudes to scheme management that fiduciary management requires. However there are signs the market is gradually coming to life.

Although only a few fiduciary mandates have been awarded to date in the UK, notably retailer Habitat, there is a huge amount of activity behind the scenes. Asset manager SEI, which offers fiduciary management to pension schemes, says it has met with over 100 funds in the last year, solely to talk about the service. Specialist advisers such as KPMG and Capita Hartshead are helping trustees to evaluate the market.

Traditional consultancies are also having some success in converting existing clients with whom they already have a relationship, into clients of fiduciary management-type services, sometimes referred to as ‘implemented consultancy’.

Mercer, for example, has taken on 87 fiduciary clients across Europe since 2006, with assets under management of over $4.5bn at the end of May. “We have huge demand from clients in the UK who want to delegate for reasons of governance, focus, efficiency and cost,” says Michael Kinney, director of implemented consulting at Mercer.

But just as fiduciary management is taking off here, the reverse seems to be happening in its homeland of the Netherlands – many pension funds are now re-examining their managers, and in extreme cases terminating them on the grounds of poor investment performance and the risks involved in delegating the entire strategic advice, risk control and asset management piece to a single third party.

Resolving turbulence

Most criticism centres on two main concerns. Firstly, many managers are felt to be selling nothing more than a rebranded multi-manager solution – essentially selecting and packaging up various investment funds – with little regard to the liability side of the balance sheet.

Secondly, providers that come from an asset management background have been accused of investing the majority of their fiduciary business in their own in-house funds, then defending such decisions on the basis of reduced fees and better visibility.

“A fiduciary manager needs to be able to act like a trustee in manager selection and some providers are conflicted in picking funds,” says Ashish Kapur, European head of institutional solutions at SEI.

“They may argue it is cheaper but cost is not an indication of quality. You can see how pressure could be applied internally to choose a certain in-house fund, or how on termination the in-house fund manager may apply pressure to allow them to be given the benefit of the doubt.”

Tony Broccardo, chief investment officer of the £16bn Barclay’s UK Retirement Fund, agrees with the need to draw on a wide range of investments. He says “even medium performance” is not enough.

“You need to target exceptional performance, which will mean third party skill across equities, credit, hedge funds, private equity and other above average sources of return. Therefore, having the widest range of funds to select from is important.”

Cost and risk

Despite these concerns, one big attraction of fiduciary management is cost. Fiduciary managers claim they are able to lower costs by as much as 20-30% in some cases, and costs are also more predictable. This may be partly because a scheme has decided that it can operate with fewer advisers such as investment consultants if it is using a fiduciary manager, or that it needs reduced involvement from consultants.

Much of the rest of the savings are from negotiation between the fiduciary manager and asset managers to drive down fees through economies of scale, providing small pension funds with better deals than they could achieve alone.

A good fiduciary manager will also bring substantial benefit in selecting appropriate assets to fit the amount of risk the scheme is prepared to take on. “The most important need is for the fiduciary manager to recognise both sides of a scheme’s balance sheet – to get to grips with the nature of the pensions liabilities (ie the amount of money the fund must pay out in pension promises), the funding ratio (the relationship between the scheme’s assets and its liabilities) and the cash flows,” says Andrew Slater, UK managing director at governance specialist Ortec Finance. “The integration of the asset and liability side should help drive a proper asset liability approach. Sometimes there is not a great conversation between them.”

Lodewijk van Pol, head of fiduciary management at Lombard Odier in Amsterdam, says: “A good fiduciary manager will be looking at where it is rewarding to pursue alpha (i.e. returns above the performance of an index such as the FTSE 100), and will make a clear distinction between the liability-matching portfolio and the return portfolio.”

He says the crisis has also made it clear that some trustees did not understand the make-up of their investments, where their assets were allocated and what was held in certain mandates, resulting in poor investment decisions. “A fiduciary manager will implement a relatively simple set up, look at how the mandates have been put together and how it works, then explain policy and structure to the trustees.”

In terms of investment decision-making, many trustees feel unable to move quickly to take advantage of opportunities in the market or move out of positions which could be damaging. A recent survey by fiduciary management provider Russell Investments revealed 40% of trustees were not confident in their ability “to respond quickly to new situations”. This could be for a variety of reasons, such as training needs, the structure of the trustee board’s decision-making process or concerns over the extra costs involved in changing asset allocation.

Whatever the reason, in the rapidly changing market environment that we have seen over the last few years, the ability to move quickly to ‘lock in’ the benefits from funding gains when the investments hits certain trigger points can be important. By focussing purely on investment, fiduciary managers are well positioned to do this.

Lloyd Raynor, a senior consultant at Russell Investments, says: “If a fund is ahead of its journey plan, the trustees may look to lock in returns on their return-seeking assets and this requires real-time expertise.”

While a fiduciary manger’s ability to look at a portfolio holistically has advantages, trustees must still be aware of how this is being implemented, says Barclay’s UK Retirement Fund’s Broccardo.

“Fiduciary management is climbing a wall of worry,” he says. “Is the mandate appropriate in terms of risk and return? Are the performance targets sufficient and appropriate? And there is the issue of agency risk – if all the underlying management and investment is dealt with by one party, there will be a lack of flexibility for trustees who wish to change manager in the future or in the event of corporate restructure.”

Deciding whether fiduciary management is right for their scheme requires trustees to consider how it will fit with their existing advisory structure (or what changes they will need to make to ensure that it fits) and whether the cost benefits will be realised for their scheme. However, increasing numbers of schemes are at least beginning to ask themselves those questions.